What Is Insurance Fraud?

Internal Fraud

One type of insurance fraud is internal fraud, which is perpetuated by insurance agents, managers or other employees of an insurance company. The employee may issue fake policies, lie on state or federal forms, or steal an insured person's payments. Internal fraud directly affects the policyholders as well as the company. You can protect yourself from internal fraud by contacting your state's insurance department to make sure you are dealing with a licensed agent of a legitimate insurance company. In addition, you should read all paperwork before you sign it, make sure you receive a policy from the insurance company itself and not just the agent, and never pay your insurance premiums in cash, which is easier to steal.

External fraud is perpetrated by policyholders and other people who benefit from an insurance payout, such as doctors or beneficiaries. One form of external fraud is making a fraudulent claim in order to receive benefits -- for example, staging an auto accident to get a payout from your car insurance or faking your own death to receive life insurance money. Another is exaggerating claims -- for example, a doctor billing your medical insurance company for $100 worth of tests when he only did $50. A third is misrepresenting facts on a claim -- for example, a driver stating that an existing injury was caused by a car accident or a pharmacist issuing generic pills and claiming he issued brand-name drugs.

According to the Nebraska Department of Insurance, insurance fraud is the second-largest economic crime (the first is tax evasion) and costs the average family $1,000 per year. This is because when insurance companies lose money due to fraud, they spread out the costs among all policyholders, leading to higher insurance costs and more denied claims. This leads to a vicious cycle of more insurance fraud, mostly involving "white lies" and small exaggerations on claims. Research by the Coalition Against Insurance Fraud found that two-thirds of Americans believe insurance fraud can be justified because of unfair practices by insurance.

The penalties for insurance fraud vary depending on each state's individual laws. One possible punishment is jail time, which ranges from three months in the District of Columbia to up to 25 years in Colorado. There may also be a hefty fine and/or restitution -- paying back the defrauded money. In Florida, a licensed professional can lose her license if convicted for insurance fraud. A judge may also order community service. Many states offer immunity from prosecution if you became involved in insurance fraud unintentionally and provide information to aid fraud investigators.